Borrowing money to buy investments means that you can invest more than if you only use your own savings.
This strategy, also known as “leveraging”, can boost returns, provide a tax advantage, force you to save and allow you to increase your stock market holdings. But be careful! Leveraging is very risky and not for everyone.
Here are some key points to consider before leveraging
The person offering the investment
Check whether the person and the firm where he or she works are authorized to offer the financial products they are recommending. You can do so by calling our Information Centre or consulting the Register of firms and individuals authorized to practise on our website.
Jot down the main points discussed with your representative so that you can refer to them if necessary.
The investment and the strategy
Carefully read through the documents you receive so that you fully understand and can accurately assess the risks of this strategy. Could the return be lower than the borrowing rate (after income tax is taken into account)? Could the recommended investments lose value? What would you do if that were to happen?
If your investments shrink in value, the financial institution that loaned you the money may ask you to pay back all or part of the loan immediately. So in addition to losing money on your investments, you would also have to repay the full amount of the loan you took out plus interest.
For example, suppose you borrow $100,000 to purchase an investment that declines in value and ends up being worth only $60,000. Your financial institution may demand that you repay all or part of the loan immediately. Even if the investment regains some value, you won’t be able to recoup the money you’ve invested.
Generally, a loan for investment purposes should not exceed 30% of your total assetsTotal assets are what a person or company owns (their assets: money in the bank, buildings, furniture, etc.) minus their debts (their liabilities: mortgage loan, etc.). (minus debt) and 50% of your liquid assets (minus debt)Total assets are the assets that a person or company has (money in the bank, buildings, furniture, etc.) minus their debts. Liquid assets (minus debt) are the portion of the assets that can be quickly and easily converted into cash.
Liquid assets (minus debt) can include shares that are traded on a stock exchange (which can be sold very quickly), but not buildings (whose sale extends over a longer period). . For example, if your net liquid assets total $200,000, you shouldn’t take out an investment loan for more than $100,000. The balance sheet on our website may be useful. But be careful! It’s not because you meet these limits that leveraging is right for you.
Your personal circumstances
Here are some tips to remember:
- Make sure that you won't need to withdraw the amounts invested before 5 to 10 years.
- Borrow only what you can repay without having to sell your investment.
For example, you should be able to pay back your loan even if the value of your investment falls to zero.
- Check your risk tolerance.
Is it high enough to use leveraging? This strategy is generally not appropriate for conservative investors, who are looking for low-risk investments. Estimate your losses in a worst-case scenario. For example, if the stock markets shed 30% of their value, how much money would you lose on your investments? Would you be able to handle such a decline? Keep in mind that despite these losses, you’ll still have to pay back your loan.
- Make sure you’re in good financial shape.
If you’re already struggling to pay down your debts and loans (mortgage, credit cards, etc.), leveraging is probably not for you. You should be able to reimburse the loan (plus interest) without getting into financial trouble.
Once you’ve taken out a loan
Let your representative know if your financial situation deteriorates or has changed significantly. For example, divorce, job loss and retirement are events that should prompt you to review whether leveraging still makes sense for you. Keep tabs on interest rates because when they rise, the cost of borrowing usually increases.
Is your marginal effective tax rate (METR) high enough to benefit from the tax deduction?
The METR is the percentage of tax that you pay on an additional dollar of income, taking into account the main government benefit programs such as the Canada Child Benefit and the GST credit. If your income increases, these benefits decrease.
One advantage of leveraging is that the interest paid on the borrowed funds can generally be deducted. This makes leveraging a good fit for investors with sufficiently high METRs. However, this should not be the only criterion to consider when deciding whether or not to use this strategy.End of the insight